PPE Shortages and the Failure to Increase Prices

Ryan Peterson, Flexport Founder and CEO, has an excellent piece on Why There Aren’t Enough Masks, and How to Get More. One part of the problem is a lack of working capital brought about in part by a fear of raising prices:

Typically, buyers of PPE, whether hospitals or medical distributors, expect to place purchase orders and only pay for products upon delivery, or even later.

But when demand surges by 20x, vendors simply don’t have the money required to scale production. Factories need money to add production lines, buy raw materials, and hire workers. They need down payments so they can move.

Buyers prefer to pay upon receipt of goods for two reasons. The first is to ensure quality: They can refuse payment if the goods they receive don’t meet their standards. The second reason is they prefer to keep cash on their balance sheets, rather than paying vendors in advance.

In ordinary times, sellers will accept this. But with the entire world desperate to buy PPE, manufacturers know they can ask for a down payment and get it. Other more aggressive entities are paying down payments, so if US buyers won’t, they don’t get the supply.

American medical distributors, governments, and even hospital chains, by contrast, have been less willing, or less able, to adapt to the new reality of paying vendors upfront, at higher prices than they’d contracted.

At the same time, US distributors can’t pass higher prices through to hospitals in the midst of the crisis, for fear of being accused of profiteering. Foreign governments and healthcare systems have been less encumbered by this, showing a willingness to pay more and pay faster to get first in line.

There was a recent debate on twitter about so-called price-gouging. It was said that the argument for raising prices is weak when the elasticity of supply is low. That’s not necessarily true. First, in an emergency even a small increase in quantity can be very valuable so high prices can have high utility payoffs. Second, vendors face credit market frictions and capital constraints. Borrowing in an emergency is often not possible–this means that asset balances matter and transferring wealth from buyers to firms can ease financial constraints. Put another way, it’s the short run increase in price which allows long run elasticities to increase. Elasticity is endogenous to pricing.

Hat tip: Paul Graham.